China’s Greatest ‘Unhealthy Financial institution’ Exams Beijing’s Resolve on Monetary Reform

HONG KONG – BlackRock gave him money. Goldman Sachs too.

Foreign investors had good reason to trust Huarong, the sprawling Chinese financial conglomerate. Even when executives showed a dangerous appetite for risky credit and credit, investors believed they could count on Beijing to bail out the state-owned company if things ever got too tricky. China had always done that.

Now some of these overseas investors may have to think twice. Huarong has more than $ 40 billion in debt to overseas and domestic investors and is showing signs of stumbling. The Chinese government, which has remained silent about a bailout, is at the early stages of restructuring planning that will result in significant investment losses from both foreign and Chinese bondholders, according to two people familiar with the government’s plans .

Beijing has spent decades bailing out Chinese companies that have sat over their heads but has vowed to turn off the faucet in recent years. While regulators have promised to set an example of financial institutions that have taken out loans and waited for the government to pay the bill, Huarong tests the limits of that determination.

Unlike the few small banks and state-owned companies that have been allowed to fall apart, Huarong is a central part of China’s financial system and some say “too big to fail”. Because of its vulnerable status, China’s leaders have made a tough choice: let it default and permeate investor confidence in the government as the lender of last resort, or save it and undermine efforts to surging debt tame that threatens the overall economy.

Analysts say Huarong’s future could be the strongest indicator of China’s commitment to financial reform.

“The regulator and investors are playing a kind of chicken game,” said Zhangkai Huang, an associate professor at Tsinghua University in Beijing. “The regulator says there will be serious reforms in the financial system. Investors say, “I bet you don’t have the courage to allow this failure because there is going to be a crisis.”

Mr. Huang, who teaches finance, said the false sense of security created by government bailouts in China created an environment similar to that in the US before the 2008 financial crisis, when investors placed bets that they would be safe.

If the government continues its plan to clean up Huarong, it will be the most dramatic statement yet that China is willing to sacrifice the investors who lend its companies money in its pursuit of reform.

The timetable for a full overhaul of the company’s operations has not yet been set, but those familiar with the government’s plans said China is determined to ensure that both foreign and domestic bondholders do not receive full repayment of their principal. The aim is to dissuade people from investing in risky Chinese companies on the assumption that the government will bail them out.

Huarong was born two decades ago when China’s state-run economy began to open up. Before state banks turned to the global marketplace to raise money, they had to reduce debt to become more attractive. Huarong took some of the ugliest loans from these banks and was given the bad bank title for this reason.

Of the four bad banks in China, Huarong became the largest, expanding his empire by financing businesses in the energy, insurance, real estate, and beyond. She used her access to cheap government bank loans to invest in risky, higher-yielding businesses. She used her international arm to raise money from overseas investors to whom she now owes more than $ 20 billion.

Huarong’s risk-taking was greatly eased under the leadership of Lai Xiaomin. Mr. Lai, the former chairman of Huarong, was stripped of his Communist Party membership in 2018 and executed in January for corruption and abuse of power, a highly unusual punishment that experts say should send a message.

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May 17, 2021, 12:48 p.m. ET

Mr. Lai confessed to taking $ 277 million in bribes and told state television that he had kept $ 30 million in safes at his Beijing home, which he called his “supermarket” .

Chinese regulators fear that the corruption shown by Mr. Lai is so deeply embedded in Huarong’s business practices that assessing the full extent of its losses and collateral damage from possible failure is challenging.

“The size and the amount of money in Lai Xiaomin’s case are shocking,” said Li Xinran, an oversight agency for the Central Disciplinary Commission. “This shows that the current situation in the fight against corruption in the financial sector is still serious and complex. The task of preventing and solving financial risks is still very difficult. “

Shortly after Mr. Lai’s execution, Huarong hit the headlines again when he said he would delay the release of his annual results in March. Annual results were postponed a second time last month, raising concerns about the financial condition and ability to repay investors.

Any situation where Huarong cannot fully repay its investors would hit some of the largest and most well-known investment firms in the world. When the international financial market grappled with this scenario, bonds recently went into a crisis.

This year alone, Huarong owes foreign investors $ 3.4 billion. After the annual earnings release was delayed, the bonds sold for just 60 cents a dollar. In Hong Kong the population has been suspended.

It is very late for a major corporate restructuring, said Larry Hu, head of the China Economics Desk at Macquarie Group. “Huarong is already too big to fail,” he said. “It is no longer a solution to the problem, but the problem itself.”

The government’s latest plan, which has not yet been reported, is likely to disrupt the Chinese corporate market. Last month, The broader market for Chinese companies began to shake as fearful investors pondered the potential for contagion.

Chinese companies owe nearly $ 500 billion in loans to foreign investors. A Huarong default could prompt some international bondholders to sell their bonds in Chinese state-owned companies and make it difficult for Chinese companies to borrow from foreign investors, which is a major source of funding.

Concerns about the company’s ability to raise fresh money prompted two rating agencies to alert Huarong to a “guard” – a kind of warning that his debt could be downgraded, making his ability to borrow even more expensive .

“There’s no playbook for that,” said Logan Wright, director of China research at Rhodium Group, a consulting firm. China’s regulators are now faced with the challenge of delivering on a promise to clean up the financial system while preventing a possible collapse, he said.

“They are introducing Beijing’s new rhetoric that they are going against the assumption that they will ensure the stability of the system,” he said.

The government is likely to put some money into the reorganized company that ultimately emerges from Huarong’s troubles, but it is unwilling to invest enough money to repay all of the bonds, said the two people familiar with the government’s plans.

While the government is devising a plan to downsize Huarong, the company has tried to calm investors’ nerves by promising it can pay its bills. Speaking to the state media, Xu Yongli, Vice President of Huarong, compared his company with other major Chinese financial institutions.

“The government support that Huarong receives is no different,” he said.

Alexandra Stevenson and Cao Li reported from Hong Kong and Keith Bradsher from Beijing.

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